Whenever I’m explaining the challenges of inflation, with a client, I always stress these three points:
- Even a low annual inflation rate of 2% reduces purchasing power by roughly 50% over a 20-year period.
- Investors need a compounding strategy that increases annual retirement income by at least the rate of inflation. We suggest dividend growth stocks.
- A rules-based strategy (if successfully back-tested) helps remove emotions and gut reactions from the investment strategy and may lead to better long-term results.
At the very least, an investment portfolio must grow at the rate of inflation otherwise it may be better to hide your savings under your mattress.
Inflation is a persistent threat to investors
While there are many things that can derail your life planning, inflation is one of those Jekyll and Hyde characters that can be great for your investments or can wipe out your savings like a swarm of hungry locusts.
What I mean is, the Canadian inflation rate averaged 3% from 1915 to May 2021, and as of May, is currently 3.6%. So, according to the Bank Of Canada’s Inflation calculator, if you spent $1,000 on a basket of goods and services on January 1, 2000, the same basket would cost approximately $1,485.77 in May, 2021.
That is a cumulative increase of 48.58% over 21 years, which sounds like a huge increase but broken down annually, it is “only” 1.90% per annum.
Why is inflation so important to understand?
Understanding inflation is important because it’s the difference between an extra-large Double Double and a small Double Double. Or possibly even, no Double Double at all.
Using the example above, if I retired on January 1, 2000, and estimated my retirement expenses and income at $75,000 per year, my retirement income must rise to approximately $111,433 in May 2021, simply to buy the same basket of goods and services.
The magic of compounding interest
Inflation is a great example of compounding in the wrong direction, i.e.; the value of your cash gets incrementally worse. But compounding can go both ways. Let’s say you invested $500,000 on June 30, 2011, and followed the buy/sell recommendations of the Richard Dri Canadian Dividend Growth model. 10 years later on June 30, 2021, your account would have grown to approximately $1.6 million.
Typically, Investors search for investments that compound in a positive direction. So if your objective is to achieve financial freedom, you must use compounding investments, such as:
Guaranteed Investments Certificates (GICs): GIC’s pay simple compounding interest but the rates are currently low and may not cover the rate of inflation. The current rate for a 5-year nonredeemable GIC, compounded annually is 1%, as of July 17th, 2021.
Real Estate: Rent generally compounds at (or above) the rate of inflation, however, rental properties have maintenance and management needs that require time and effort. Perhaps a Real Estate Investment Trust ( REIT) may be the better option as it removes the day-to-day management of the rental property.
Dividend growth stocks: Invest in companies with a long history of paying a quarterly dividend and increasing their dividends at least annually. The increasing dividends can be used to purchase additional shares in the payer company (usually at a discount to market). Since dividends are usually paid quarterly and increase annually, It’s a viable option for a compounding model and requires very little personal effort.
Enbridge, a long-term compounding success
A great example of a quality dividend grower is Enbridge. Enbridge has paid a dividend for over 66 years and over the last 26 years, the dividend has grown at an average compound annual growth rate of 10%, which easily beats the inflation rate over the same period, and would have kept your retirement income growing comfortably.
In short, you don’t need to find the next Google or Amazon; build a personal compounding model by finding and investing in proven dividend growth stocks, which you can reinvest or even live off: How to Live Off Your Dividends.
It is not a game of chance
Gambling can be a lot of fun, and yes, occasionally it can pay off. There are even those rare people who gamble professionally, but over my 25+ year career, I have always said that investing in stocks/publicly listed companies is not a game of chance.
Despite knowing that a stock’s performance is not entirely predictable, I don’t consider investing in dividend growth stocks as gambling, as I believe there are many ways to remove some chance from the equation and make decisions that deliver more consistent returns.
A rules-based approach
I believe the key is to eliminate hunches, hot tips and gut feelings from the mix. And, most of all, to never think about luck. What is needed is a rules-based investment model that distills years of market data and careful analysis into a clear set of rules that must be followed and never broken.
Prior to launching the Richard Dri Canadian Dividend Growth model, I hired Morningstar research company to compare the best dividend growth stocks over the last 35-years and identify whether these stocks had anything in common.
The study proved that many of the best-performing dividend growth stocks did indeed have similar characteristics. Armed with this information, we worked together and built an algorithm that matched these common characteristics. I tested the theory by following the buy/sell rules of the algorithm and recorded the returns over the previous 30-year period, and I’m proud to say that the model showed superior returns when compared to the S&P/TSX over a 10-year and a 31-year period.
It is important to understand that the model ebbs and flows like any other investment portfolio, however, what is critical is that the fluctuations are smaller in magnitude than the S&P/TSX. For example, as of June/30, the model’s 10-year return-on-investment is 12.4% versus the S&P/TSX at 7.4%.
Final thoughts
It is obvious that a robust model is needed to ensure that your retirement planning is successful. So I recommend that you ask yourself:
- Is your portfolio keeping up with inflation?
- If inflation increases up to the long-term average of 3.1%, will your retirement income be able to keep pace?
- Do you know your retirement income sources and are they inflation adjusted?
If you have a nagging doubt with any of these questions, please call my office and arrange an appointment to discuss how to protect yourself against inflation.
The process of finding a financial advisor can be overwhelming. It is our job to make that process simpler and easier.
Dri Financial Group’s proprietary Wealth Navigator Process is designed with you in mind.
Its structured framework helps you make an informed decision and feel confident in our team and management practices before we get started.
We offer you a range of services from creating bespoke financial plans and providing investment advice to helping you take advantage of our investment models. If you would like more information on the Wealth Navigator Process or our team, call me any time at 416.355.6370 or email me at richard.dri@scotiawealth.com.
—
Beyond helping you manage your finances, we take pride in motivating, educating and helping you expand your financial literacy. We are here to answer any questions you have and to help you feel in control of your financial destiny.
If you are ready to dive deeper into your financial literacy journey, we have a wide range of free tools and educational resources available.
- Subscribe to our Never Retire Newsletter
- Contact us to order a complimentary e-book
- Check-out our latest Wealth Navigator Podcast
- Follow me on LinkedIn
source https://richarddri.ca/how-inflation-threatens-investment-success/
Dri Financial Group 